RAILWAY  FREIGHT  RATES 

THE  LEGAL,  ECONOMIC,  AND  ACCOUNTING  PRINCI- 
PLES INVOLVEli/^i^  'WfifRffjiifa'f^lIj^AL, 
DETERMINATION. 


MAURICE  H.   ROBINSON 

of  the  University  of  Illinois 


Yale  Economic  Papers 


The  Yale  Publishing  Association, 
135  Elm  Street,  New  Haven,  Conn. 


This  article  is  reprinted  from  the  Yale  Review,  a  Journal  for  the 
Scientific  Discussion  of  Economic,  Political  and  Social  Questions.  Published 
Quarterly  by  the  Yale  Publishing  Association,  New  Haven,  Conn.  Antiual 
Subscriptions  Three  Dollars. 

Extra  copies  of  this  reprint,  ten  cents  each. 


OAK  ST.  HD^'^ 


^  ^  "^  UNIVERSITY  OF  HLWOIS  UBRAITir 

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f*  RAILWAY  FREIGHT  RATES. 

The  Legal,  Economic,  and  Accounting  Principles  Involved  in 
their  Judicial  Determination. 


CONTENTS. 

Economic  importance  of  freight  rates,  p.  i  ;  nature  and  effects  of  rates 
based  upon  what  the  traffic  will  bear,  p.  6  ;  the  cost  of  the  service  principle, 
p.  8 ;  legal  principle  governing  freight  rates,  p.  lo  ;  general  accounting 
principles  involved,  p.  ii  ;  earlier  methods  adopted  by  the  Interstate  Com- 
merce Commission,  p.  I2 ;  tendency  towards  use  of  the  cost  of  the  service 
principle  by  the  Interstate  Commerce  Commission,  p.  i6;  cost  of  the  ser- 
vice principle  as  applied  in  the  Spokane  case,  p.  i8  ;  the  cost  of  the  service 
principle  as  inaugurated  and  used  by  the  Wisconsin  Railroad  Commission,  p. 
21  ;  the  Talcott  method  of  cost  accounting,  p.  29 ;  comparison  of  the  Wis- 
consin and  Talcott  methods,  p.  31  ;  the  universal  freight  unit  method,  p.  32; 
the  cost  of  the  service  the  ultimate  basis  toward  which  freight  rates  are  tend- 
ing, p.  32. 

I. 

A  S  compared  with  the  passenger  service,  the  work  of  the 
-^"^  freight  department  of  a  railroad  is  not  only  much  more 
important,  from  the  economic  point  of  view,  but  it  is  also  of  such 
exceeding  complexity  in  its  operations  as  almost  to  defy  the  skill 
of  the  highest  accounting  talent  adequately  to  present  those  opera- 
tions in  the  form  of  accounts.  As  stated  in  a  previous  article,^  in 
their  passenger  service  the  railroads  are  able  to  depart  from  the 
equal  mileage  principle  in  so  few  cases  that  questions  connected 
with  discrimination  between  passengers  very  seldom  arise.  Pas- 
senger rates  may  be  fixed  too  high  as  a  whole  to  meet  the  existing 
legal  and  economic  conditions,  but  only  in  extraordinary  cases  is 
there  likely  to  be  discrimination  between  individuals,  classes,  or 
localities.  Freight  rates,  on  the  other  hand,  may  be  in  some  cases 
higher  than  economic  conditions  justify,  and  yet  too  low  in  all 
other  cases,  thus  bringing  about  a  condition  where,  even  while 
charging  too  high  rates  in  certain  instances,  the  railroad  is 
financially  ruined.     The  reason  for  this  peculiar  situation  lies  in 

'Yale  Review,  February,  1908. 


2  Yale  Review. 

the  nature  of  the  business  and  in  the  conditions  under  which  it 
is  conducted. 

In  the  first  place,  competition  between  railroads  for  the  freight 
business  available  varies  from  the  phase  of  the  keenest  rivalry  to 
that  of  complete  monopoly.  Even  under  the  usual  economic 
conditions,  therefore,  freight  rates  vary  from  a  figure  barely 
sufficient  to  cover  the  actual  cost  of  moving  the  goods  to  one 
under  which  quite  unusual  profits  are  returned  to  the  railway 
stockholders.  Industries  located  at  competing  points  enjoy  an 
advantage  over  those  located  at  non-competing  points  which  is 
equal  to  the  difference  in  rates.  When  competition  between  the 
various  manufacturing  establishments  becomes  keen  and  active, 
those  located  at  non-competing  points  are  necessarily  bankrupted 
unless  they  are  able  to  secure  reductions  from  the  railroads  suffi- 
cient to  counterbalance  their  economic  disadvantages.  The  very 
existence  of  any  unfortunately  situated  industrial  establishment 
is  thus  at  the  mercy  of  the  railway  officials.  Where  this  power 
is  exercised  with  discretion  and  sympathy,  no  serious  economic 
harm  is  likely  to  follow;  but  the  danger  that  it  may  be  used 
wantonly,  or  in  a  spirit  of  ignorance  or  revenge,  is  so  great  that 
some  control  over  rates  is  uniformly  entrusted  to  the  public 
authorities.^ 

In  the  second  place,  certain  shippers  of  freight  are  absolutely 
dependent  upon  the  railways  for  the  transportation  of  their  goods, 
while  others  are  in  a  position  to  provide  means  for  carrying  their 
own  products  whenever  rates  are  advanced  much  above  the 
average  cost  of  transportation.  The  shippers  in  the  first-named 
class,  comprising  all  small  manufacturers  and  all  of  the  com- 
mercial classes,  must  in  general  pay  the  rates  made  by  the  rail- 
roads or  go  out  of  business.^     So  long  as  the  rates  actually  in 

'"Railway  officials  free  from  restrictions  could  make  or  unmake  mining 
and  manufacturing  concerns  in  those  days  [1860-1880]  and  could  do  so  still 
had  we  not  at  last  a  court  of  appeal  and  laws  against  obvious  discriminations. 

"The  Interstate  Commerce  Commission  is  to  become  one  of  our  greatest 
safeguards." — Andrew  Carnegie  in  "My  Experience  with  Railway  Rates  and 
Rebates."    Century  Magazine,  March,  1908. 

•  It  is,  of  course,  conceivable  that  every  community  might  become  self- 
supporting,  manufacturing  its  own  goods  from  materials  grown  on  near-by 
farms  or  taken  from  local  mines  and  forests,  and  transporting  the  same  with 
its  own  teams.  Such  a  condition,  while  conceivable,  is,  of  course,  not  possible 
so  long  as  railroads  exist. 


Railway  Freight  Rates.  3 

force  permit  business  to  be  carried  on  even  at  a  small  profit,  there 
remains  an  economic  incentive  for  men  to  engage  in  such  under- 
takings, although,  of  course,  free  capital  will  gravitate  toward 
those  industries  where  there  is  opportunity  for  self -protection 
through  the  establishment  of  direct  transportation  facilities. 
Rates  cannot,  therefore,  be  profitably  carried  above  what  the 
traffic  is  able  to  bear  and  still  continue  to  maintain  itself  in  a 
fairly  prosperous  condition.  Shippers  in  the  second  class  possess, 
however,  a  tremendous  advantage  over  those  of  the  first  class 
when  dealing  with  the  question  of  railway  rates.  Carnegie  used 
this  power  with  telling  effect  in  making  terms  with  the  Pennsyl- 
vania Railroad  for  the  shipment  of  iron  and  steel  products  from 
the  Pittsburg  district  to  the  Atlantic  coast.*  The  Steel  Corpora- 
tion has  followed  out  the  policy  originated  by  Carnegie,  until  at 
the  present  time  it  owns  and  operates  an  extensive  system  of 
railways  and  steamship  lines,  rendering  it  practically  independent 
of  all  outside  facilities  in  the  transportation  of  its  ore  and  coal 
from  the  mines  to  the  mills.^  The  Standard  Oil  Company 
adopted  the  same  policy  in  its  early  history,  through  the  purchase 
and  construction  of  pipe  lines  for  the  transportation  of  oil*;  it 
has  also  an  extensive  fleet  of  ocean  steamers  especially  con- 
structed for  the  transportation  of  oil  to  foreign  countries.  It  has 
thus  been  able  to  secure  railway  and  ocean  rates  at  all  times  and 
between  all  places  at  about  the  actual  cost  of  the  service  to  the 
transportation  companies.  The  same  principle  has  been  applied 
in  many  other  lines,  and  always  for  the  same  purpose  and  with  the 
same  results :  the  anthracite  tide-water  canals  were  projected  and 
developed  to  secure  low  cost  transportation  for  coal  to  the  factory 
towns'^;  and  in  more  recent  years  a  large  number  of  railways* 
have  been  built  by  manufacturing,  mining,  and  lumbering  com- 
panies, partly  at  least,  for  protective  purposes. 

*  Carnegie,  "My  Experience,"  etc. 

'U.  S.  Steel  Corporation,  "Annual  Report,"  1908. 

'Report  of  Commissioner  of  Corporations  on  the  Petroleum  Industry, 
Part  I,  pp.  51,  122. 

^  Jones,  "The  Economic  History  of  the  Anthracite  Tide  Water  Canals." 

'Senate  Document  No.  37,  6ist  Congress,  ist  session,  decision  of  the 
Supreme  Court  in  the  Interstate  Commodities  clause. 


A  Yale  Review. 

In  the  third  place,  the  cost  of  transporting  freight  in  its  various 
forms  and  under  the  many  different  conditions  under  which  it  is 
offered  for  shipment  has  never  been  worked  out  in  a  satisfactory 
way  by  railway  officials.  Rates  are  made  not  on  the  cost  of 
transportation,  but  on  the  principle  known  as  "what  the  traffic 
will  bear."  Since  some  commodities  will  not  be  shipped  at  all 
except  at  a  very  low  rate,  and  since  at  a  low  rate  their  returns 
more  than  cover  the  known  direct  expenses  incurred  on  account 
of  such  shipments,  rates  are  made  in  such  cases  far  below  the 
average  rate.  Other  commodities  move  freely  and  in  large 
quantities  at  a  relatively  higher  rate,  and  as  a  consequence  higher 
rates  are  maintained  by  the  railroad  companies.  Rates  are  there- 
fore generally  made  on  the  basis  of  benefits  conferred  rather  than 
on  the  cost  of  the  service.  Traffic  officials  watching  the  flow  of 
various  classes  of  commodities  under  changing  rates,  become 
experimental  philosophers  of  no  mean  ability  in  dealing  with  the 
economic  life  blood  of  the  nation.  As  railways  give  more  atten- 
tion to  cost-accounting  in  its  application  to  various  classes  of 
freight,  many  of  the  lowest  rates  are  absolutely  sure  to  be  raised 
and  some  of  those  relatively  high  will  undoubtedly  be  lowered; 
this  in  itself  will  bring  about  greater  uniformity  in  the  burden 
imposed  by  freight  transportation  upon  the  commodities  which 
it  moves. 

In  the  fourth  place,  even  though  all  the  railroads  were  consoli- 
dated into  one  system,  even  though  the  science  of  accounting 
were  fully  developed  in  its  application  to  the  railway  service,  and 
even  though  shippers  had  no  way  of  securing  transportation 
except  by  means  of  the  railways,  certain  rates  would  yet  be  much 
lower  than  the  average  and  others  much  higher ; — the  result  being 
discrimination  between  persons,  places,  and  commodities  even 
where  the  conditions  under  which  the  service  is  undertaken  are 
substantially  similar  from  the  railway  standpoint.  This  state  of 
affairs  is  the  result  of  the  unequal  ability  of  such  persons,  places, 
and  commodities  to  pay  railway  charges,  and  of  the  effort  of  the 
railways  to  secure  from  each  all  the  traffic  is  able  to  bear.  To 
illustrate :  the  cost  of  raising  wheat,  omitting  from  consideration 
for  the  moment  the  rent  of  the  land,  varies  somewhat  at  points 
in   the   wheat  lands   of   Manitoba,   the   Dakotas,   Kansas,   and 


Railway  Freight  Rates.  5 

Oklahoma.  The  selHng  price  in  the  central  market  of  Chicago 
is,  owing  to  the  presence  of  active  competition,  the  same  for  the 
same  grade  of  wheat.  Assuming  that  the  cost  of  transporting 
the  wheat  to  the  market  from  each  of  these  fields  is  practically- 
identical,  the  lands  where  the  cost  of  raising  wheat  is  lowest  will 
increase  in  value  up  to  a  point  where  the  earnings  to  the  wheat 
farmers  becomes  practically  equal  so  long  as  the  railways  charge 
rates  that  are  based  upon  the  cost  of  the  service.  The  railways, 
however,  discovering  that  the  cost  of  raising  wheat  is  low  in 
certain  districts  and  that  therefore  the  farmers  in  that  locality  are 
able  to  pay  a  higher  rate,  establish  and  maintain  rates  consider- 
ably higher  for  this  locality  than  for  those  where  the  cost  of 
raising  the  wheat  is  higher.  Such  a  system  would,  of  course,  if 
carried  out  universally,  completely  nullify  the  economic  rent  of 
land  so  far  as  the  farmers  are  concerned  and  convert  it  into  an 
added  profit  for  the  railway  service. 

Again,  the  cost  of  manufacturing  articles  of  the  same  character 
varies  considerably  at  different  points  in  the  United  States. 
When  the  transportation  rates  on  such  goods  are  on  the  same 
basis,  the  manufacturers  at  the  points  most  favorably  situated 
earn  a  higher  rate  of  return  on  their  actual  investment.  Manu- 
facturers located  at  such  points  can  pay  a  higher  rate  of  trans- 
portation and  still  maintain  their  position  in  competition  with  less 
favorably  situated  competitors.  The  railways,  by  adopting  the 
principle  of  charging  what  the  traffic  will  bear,  are  able  to  take 
from  the  better  situated  manufacturers  the  larger  part  of  this 
advantage,  thus  reducing  all  competing  manufacturers  in  the  same 
line  to  a  common  plane  of  profits.  The  same  principle  will  apply, 
of  course,  to  competing  merchants.  Thus  the  railways,  by 
eliminating  competition  between  themselves,  are  in  an  economic 
position  to  depart  from  the  cost  of  the  service  principle ;  they  can 
adopt  and  enforce  that  of  charging  what  the  traffic  will  bear  and 
thus  absorb  all  differential  profits  that  arise  from  superior  loca- 
tion and  superior  business  management  in  every  domain  of  busi- 
ness activity. 


Yale  Review. 


II. 


The  freight  service  ought  as  a  matter  of  economic  poHcy  to  be 
self-supporting,  and  accordingly  the  railways  should  make  their 
freight  rates  sufficiently  high  to  secure  that  end.  In  view  of  the 
economic  conditions  described  in  the  preceding  section,  it  is 
evident  that  this  result  may  be  secured  by  charging  compara- 
tively high  rates  in  certain  cases  and  comparatively  low  rates 
in  others,  or  by  charging  an  average  rate  based  upon  the  cost 
of  the  service  sufficient  to  pay  operating  expenses  and  yield 
in  addition  a  fair  rate  of  return  upon  the  investment.  In  the 
first  case  the  railways  adopt  and  enforce  the  policy  of  rate- 
making  known  as  "charging  what  the  traffic  will  bear,"  so  ably 
set  forth  by  Hadley^  in  this  country  and  Acworth^^  in  England. 
From  the  commercial  point  of  view,  this  system  of  rate-making 
is  an  application  of  the  ordinary  principles  of  taxation,  enforced 
through  a  quasi-public  institution  with  private  parties^ ^  as  the 
beneficiaries.  From  the  standpoint  of  accountancy,  this  method 
involves,  theoretically  at  least,  the  separation  of  railway  transpor- 
tation expenses  into  two  distinct  categories,  viz.,  operating 
expenses  and  fixed  charges.  In  the  determination  of  any  specific 
rate,  the  railway  first  finds  the  actual  cost  attributable  to  this 
particular  shipment,  and  then  adds  whatever  in  its  judgment  such 
traffic  is  able  to  bear  as  a  contribution  toward  the  general 
expenses.  The  second  portion  of  the  charge  is  the  tax  element. 
In  certain  cases  the  tax  is  light,  in  others  heavy :  the  combination 
of  operating  expenses  plus  a  light  tax  makes  a  low  rate ;  that  of 
operating  expenses  plus  a  heavy  tax,  a  high  rate.  This  system 
not  only  has  the  weight  of  years  of  successful  experience  behind 
it,  but  has  also  been  approved  by  many  of  the  ablest  students  of 
economic  progress.  Nevertheless,  the  economic  unrest,  as 
evidenced  by  interminable  litigation  over  railroad  rates  in  the 
States  and  in  the  Nation,  indicates  that  the  system  is  open  to 
certain  fundamental  objections.  These  may  be  stated  as  follows : 
First :  The  system  subsidizes  certain  industries,  and  industries 
located  in  certain  districts,  while  taxing  other  industries  and 

•Hadley,  "Railroad  Transportation,"  Chapter  VI. 
"Acworth,  "Railway  Economics,"  Chapters  VIII-XI. 
"  Where  railways  are  privately  owned. 


Railway  Freight  Rates,  7 

other  localities;  and  so  the  subsidized  industries  and  localities 
are  stimulated  into  an  abnormal  growth  while  those  not  so 
favored  are  unduly  checked.  Since  the  subsidized  industries 
are  those  in  which  the  prices  are  relatively  low,  a  country  is  thus 
encouraged  to  use  more  of  the  goods  which  it  needs  less  because 
its  wants  are  more  fully  satisfied,  and  less  of  those  which  are  in 
greater  demand.  On  the  other  hand,  rates  are  made  low  to  pro- 
ducers in  localities  where  the  cost  of  production  is  already  above 
the  average  and  high  where  the  cost  of  production  is  low.  The 
normal  tendency  to  concentrate  production  in  those  localities 
which  are  most  highly  favored  by  nature  is  checked,  and  the 
result  is  a  somewhat  higher  average  cost  of  production  than 
would  have  been  in  evidence  had  the  railways  based  the  rates  in 
each  and  every  case  upon  the  cost  of  the  service.  The  result  of 
the  policy  of  charging  what  the  traffic  will  bear,  even  when 
applied  with  the  highest  type  of  wisdom  and  discretion,  is  thus : 
(i)  to  prevent  the  normal  increase  in  the  production  of  those 
commodities  for  which  the  community  has  the  most  urgent  need ; 
and  (2)  to  thwart  the  natural  tendency  to  concentrate  produc- 
tion in  those  localities  where  the  cost  of  production  is  lowest, 
and  so  to  maintain  a  higher  cost  of  production  than  otherwise 
would  have  resulted.  Evidently  misdirected  production  and 
unsatisfied  wants  are  the  natural  results  of  the  system. 

Second :  Owing  to  the  inherent  difficulties  experienced  in 
determining  what  the  traffic  will  bear,  errors  of  judgment,  ignor- 
ance, and  actual  fraud  so  warp  and  distort  the  system  that  the 
beneficent  results  conceived  in  theory  are  never  realized  in  actual 
practice.  Rates  fixed  above  what  the  traffic  will  bear  not  only 
dwarf  the  industrial  development  in  particular  lines  and  bar  the 
consumers  from  the  normal  satisfaction  of  their  wants,  but  at  the 
same  time  make  it  impossible  for  the  railway  to  earn  a  reasonable 
return  upon  its  capital.  On  the  other  hand,  rates  fixed  below 
what  the  traffic  will  bear  have  the  same  effect  upon  the  earnings 
while  directing  the  industrial  activities  of  the  country  into  lines  of 
development  where  the  social  benefits  are  likely  to  be  diminished. 
Moreover,  since  the  power  to  tax  is  the  power  to  destroy,  the  rail- 
ways may  not  only  prevent  the  development  of  new  industries  and 
new   territory,   but — what   is   of   more   importance — they   may 


8  Yale  Review. 

actually  destroy  industries  already  in  existence.  Of  course  it 
must  be  conceded  that  even  if  they  had  the  liberty  to  do  so,  the 
railways  would  not  consciously  check  the  general  industrial 
development  of  the  country  they  serve.  Most  railways,  however, 
serve  many  industries  and  many  distinct  geographical  districts, 
and  it  is  a  well-known  fact  that  in  the  exercise  of  the  rate-making 
power  they  have  abnormally  stimulated  the  growth  of  certain 
industries  and  localities  and  at  the  same  time  have  dwarfed,  if 
not  entirely  destroyed,  others.  Fortunately  the  system  has  never 
existed  in  any  complete  form,  except  as  a  theoretical  figment, 
owing  to  the  combined  influence  of  competing  railways,  com- 
peting centers  of  production,  competing  markets  and  the  activities 
of  State  and  national  commissions  and  courts.  With  the  rail- 
roads of  a  country  completely  consolidated  and  left  free  to  make 
and  enforce  rates  without  public  regulation  of  any  sort,  the  real 
significance  of  the  system  would  be  felt  and  appreciated.^^ 

In  the  second  case,  the  railways  adopt  the  cost  of  the  service 
principle  as  the  basis  of  the  rates.  Such  a  system  preserves  to 
every  locality  the  natural  advantages  of  its  position,  to  every 
entrepreneur  the  results  of  his  skill  in  management,  and  to 
laborers  the  most  favorable  conditions  for  work  and  wages.  Its 
rigorous  application  in  all  cases  and  under  all  circumstances  is 
of  course  impossible  and  would  not  be  economically  desirable  if 
possible.  It  may  with  beneficial  results  be  modified  in  favor  of 
existing  establishments  when  the  onward  march  of  industrial 
development  would  otherwise  ruthlessly  apply  the  issue  of  the 
survival  of  the  fittest  to  the  existing  manufacturing  plants ;  it  may 
also  be  modified  with  equally  good  results  for  the  sake  of  hasten- 
ing the  occupancy  of  new  agricultural  land  or  outlying  suburban 
districts,  and  so  of  effecting  a  more  equal  distribution  of  the  popu- 
lation, preventing  congestion  and  thus  modifying  to  a  slight  extent 

"  From  the  economic  point  of  view  the  system  of  charging  what  the  traffic 
will  bear  resembles  in  many  respects  the  protective  tariff  system.  In  each 
case  the  natural  development  of  the  country  affected  is  prevented  and  an 
artificial  development  is  promoted  and  fostered.  In  the  one  case  the  develop- 
ment is  shaped  to  augment  railway  revenues;  in  the  other,  to  foster  the 
protected  industries.  In  both  cases  the  public  suffers  for  the  benefit  of 
private  interests.  Under  one  condition  alone  can  either  system  be  justified 
from  the  purely  economic  point  of  view,  and  that  condition  involves  the 
fixing  of  the  rates  or  duties  by  an  all-wise  Providence. 


Railway  Freight  Rates.  9 

the  rigorous  application  of  the  law  of  rent.  But  these  exceptions 
are,  on  the  whole,  of  small  importance  when  wide  territorial  areas 
and  long  periods  of  time  are  taken  into  consideration.  The  indus- 
trial world  is  at  best  full  of  uncertainties,  and  whatever  tends  to 
increase  the  risks  that  must  be  borne  checks  the  normal  industrial 
development.  The  cost  of  railway  transportation  varies  very 
little  from  year  to  year  and  from  place  to  place  under  similar 
conditions ;  "what  the  traffic  will  bear"  varies  much  more  widely; 
and  therefore  the  former  system  ensures  business  stability  while 
the  latter  tends  to  make  business  even  more  risky  than  would 
otherwise  be  the  case.  That  the  cost  of  the  service  principle  as 
a  basis  of  railway  rates  is  neither  the  dream  of  a  closet 
philosopher  nor  the  ideal  for  a  future  economic  society  may  be 
seen  from  an  examination  of  the  rate  question  in  trunk  line 
territory.^^  After  years  of  experience  with  the  principle  of 
"what  the  traffic  will  bear,"  as  it  must  of  necessity  be  applied 
under  competitive  railway  conditions,  the  trunk  line  railways, 
occupying  the  territory  north  of  the  Ohio  and  east  of  the  Mis- 
sissippi,^'* adopted  in  1876  what  is  essentially  a  cost  of  the  service 
system  of  rates.  The  economic  benefits  of  this  system,  as  modi- 
fied in  1879,  are  too  well  known  to  need  examination  in  this 
paper;  its  defects  as  actually  adopted  are  connected  with  viola- 
tions of  the  cost  of  the  service  principle,  due  to  water  transporta- 
tion and  the  influence  of  western  and  southern  lines,  rather  than 
to  the  system  itself.  The  cost  of  the  service  principle  is  thus  not 
only  in  accordance  with  economic  principles,  but  has  been  some- 
what imperfectly  applied  on  a  large  scale  with  the  most  gratifying 
results. 

The  legal  principles  governing  the  regulation  of  railway  rates 
were  in  a  general  way  discussed  in  the  preceding  article^^  on  pas- 
senger rates.  Under  our  system  of  dual  control,  the  Federal 
Government  has  supervision,  so  far  as  supervision  is  entrusted  to 
any  government,  over  interstate  railway  traffic,  while  the  several 
State  governments  have  control  over  the  intrastate  business.  By 
the  Fifth  Amendment  to  the  Constitution,  the  railways  are,  it  is 

"Ripley,  "The  Trunk  Line  Rate  System:    A  Distance  Tariff."    Quarterly 
Journal  of  Economics,  Vol.  XX,  1906,  p.  183-210. 
"With  the  exception  of  the  larger  part  of  Wisconsin  and  Minnesota. 
"  Yale  Review,  February,  1908. 


'**  Yale  Review. 

thought,  amply  protected  from  the  power  of  the  Federal  Govern- 
ment should  it  attempt  to  force  interstate  rates  below  a  point 
where  that  part  of  their  business  would  yield  a  reasonable  return 
upon  the  mvestment  devoted  to  this  class  of  traffic     The  Four 
teenth  Amendment,  on  the  other  hand,  forbids  the  State  govern- 

Zm    T;  ''''"''"^  "■"''  '°  '°^  "'^'  "^^  P"^^'y  State  business 
would  fa,l  to  earn  a  normal  rate  of  interest  and  profits  upon  the 
State  mvestment.     Whether  the  governments.  State  and  Federal 
may  reduce  rates  between  particular  points  on  certain  articles  o; 
certam  classes  of  articles  below  the  general  level  of  rates,  so  long 

questL  "'"T  r  '  T'"''  "  P^'^'^"^'  '^  ^'  y^'  -  ""-"lef 
question.        Such  a  pohcy  would  result  in  rate  discrimination  by 

act  of  the  government,  not  only  between  commodities  but  between 

Peaces     wherever   commodities    so    discriminated    between    are 

h'^r  ...'"'"'"'  '°^^"""-     S'"'^^  discriminations  are  for- 
b^den  by  the  interstate  commerce  act  for  interstate  traffic  and  by 

Z  f  theT  °1''^\''^"^^  f-  '"'-^'^'e  traffic,  it  may  be  assumed 
that  .f  he  law  be  mterpreted  in  the  spirit  in  which  it  was  enacted 
without  regard  to  existing  industrial  and  commercial  conditions 
such  commodity  discriminations  would  not  be  sanctioned  by"S 

the  State  legislatures  is  one  based  upon  the  cost  of  the  service 
one  in  which  each  class  of  traffic  pays  its  own  charges;  wTere 
there  are  no  favored  classes  of  commodities  or  localitie^  on  the 
one  hand,  and  no  parasites  on  the  other. 

III. 

r.TT.7  '^'''  '"''''  "P°"  '"^  '^"'^°''  i"  proportion  to  the 
cost  of  the  service  are,  we  have  seen,  not  only  in  accord  with  tie 
gneral  principles  of  economic  policy,  but  are  also  in  conf^  •; 
with  the  spint  of  the  law  of  the  land.  Federal  as  well  as  State 

ifneTeX'^r  ^"^  '"  '"  ^  ''""''  "^^  '^^"  '"  '»-  '"  ^^ 

esults       °7an^'  I  ^™"'"°"  """  '"'"'  ^'^'=^"^"'  -^onomic 

of  t  Iffi.       ^PP'"^^"on  to  particular  cases,  or  to  particular  classes 

of  traffic  m  any  exact  scientific  way,  presents  so  many  serious 

R^rr;;,.  """"•'  '^'  "'""■•  '^■-  ^""=  "■  «■  *  o.  r.  cc,  s  i.  c.  c. 


Railway  Freight  Rates.  il 

difficulties  from  the  accounting  standpoint,  that  our  courts  and 
commissions  have  quite  generally  avoided  any  reference  to  the 
system.  As  shown  in  the  article  on  railway  passenger  rates,^'^ 
the  following  steps  are  necessary  to  its  successful  use  in  connec- 
tion with  any  specific  rate:  (i)  the  valuation  of  the  railway 
investment  as  a  whole  and  the  further  division  of  such  valuation 
by  classes  of  services  undertaken ;  (2)  the  fixing  of  a  proper  rate 
of  return  upon  such  valuations;  (3)  the  actual  separation  of  all 
receipts  and  expenses  by  classes  of  operations,  and  the  apportion- 
ment of  joint  expenses  to  the  same  classes  in  accordance  with  the 
standards  of  cost  accountancy. 

In  the  article  above  referred  to,  the  principles  governing  the 
separation  of  freight  and  passenger  receipts  were  discussed  at 
some  length.  As  a  result  of  this  process  of  separation,  the 
accounts  of  the  freight  department  of  a  railway  are  isolated  from 
the  accounts  of  all  other  departments  and  may  therefore  be  treated 
exactly  as  though  the  railway  were  devoted  exclusively  to  the 
business  of  transporting  freight.  Owing  to  the  division  of 
powers  between  the  State  and  Federal  governments,  a  second 
separation  must  be  made,  viz.,  the  accounts  for  the  intrastate 
freight  traffic  must  be  separated  from  those  for  the  interstate 
business.  As  a  result  of  this  second  step,  the  financial  affairs  of 
the  freight  department  are  divided  into  two  sections,  each  of 
which  must  again  be  treated  as  the  accounts  of  an  entirely  distinct 
railway  company.  The  problem  in  accountancy  which  must  now 
be  solved,  if  we  are  to  make  practical  use  of  the  cost  of  the  service 
principle  in  the  determination  of  a  particular  rate,  may  be  stated 
as  follows:  given  (i)  a  railroad  within  the  exclusive  jurisdiction 
of  a  government  having  authority  within  constitutional  limits 
over  its  service  and  rates;  (2)  a  system  of  rates  built  up  under 
semi-competitive  and  semi-monopolistic  conditions  and  there- 
fore constructed  so  far  as  possible  upon  the  principle  of  charging 
what  the  traffic  will  bear;  and  (3)  a  specific  industrial  establish- 
ment or  locality  entering,  through  its  chosen  representative,  a 
complaint  before  the  proper  tribunal  of  such  government,  charg- 
ing that  the  rates  upon  the  commodities  in  which  they  are  particu- 
larly interested  are  either  extortionate  (that  is,  unreasonably  high 

"  Yale  Review,  February,  1908. 


12  Yale  Review. 

in  themselves),  or  discriminatory  (that  is,  higher  than  other 
industries  under  similar  operating  conditions  are  charged  by  the 
same  or  other  railway  companies)  :  state  the  accountancy  prin- 
ciples which,  if  properly  applied  to  the  case  in  question,  will  deter- 
mine whether  the  authorities  may  properly  order  a  reduction  of 
rates  or  whether  the  existing  rates  are  reasonable  and  fair. 

(i)  The  principles  upon  which  such  cases  have  quite 
generally  been  decided  in  the  past  have  no  connection  with  the 
practice  of  accountancy.  In  other  words,  the  commissions  and 
courts  have  not,  except  in  the  most  cursory  way,  considered  the 
revenue  and  expenditures  caused  by  the  traffic  when  rates  are 
before  them  for  judicial  determination.  Usually  cases  are 
decided  by  comparing  the  rates  upon  the  specific  commodity  over 
the  particular  railway  line  in  question  with  the  rates  charged  by 
the  same  or  other  railways  upon  similar  goods  under  somewhat 
similar  circumstances.  If  the  conditions  are  dissimilar — owing 
either  to  traffic  or  operation,  or  to  the  competition  of  rival  rail- 
ways'^ or  water  routes'^ — the  railway  rates  are  allowed  to  differ 
as  much  as  in  the  judgment  of  the  public  authorities  seems  proper. 
Thus  a  low  volume  of  traffic  per  mile  of  line,  unfavorable 
operating  conditions  such  as  grades  and  curvatures,  the  absence 
of  competition  from  other  railways  or  means  of  water  transporta- 
tion, are  generally  held  to  justify  somewhat  higher  rates  than  are 
permitted  when  the  conditions  are  the  reverse.  The  assump- 
tion is  that  light  traffic  means  a  higher  cost  of  transportation; 
and  it  is  of  course  true  that  unfavorable  operating  conditions 
necessitate  a  higher  cost  of  transportation  per  ton-mile,  since  the 
two  methods  of  expression  are  practically  synonymous.  It  is 
one  of  the  functions  of  railway  accountancy  to  determine  the 
actual  cost  of  transporting  goods  under  dissimilar  conditions  of 
traffic,  equipment,  and  roadway ;  the  railways  are  making  more 
and  more  use  of  the  accounts  for  this  purpose,  both  in  self-pro- 
tection and  for  assistance  in  the  wise  administration  of  the  work. 
And  yet  until  within  the  last  two  years,  one  may  search  among 
the  opinions  of  the  Interstate  Commerce  Commission  and  the 
several  State-  commissions  in  vain  for  even  a  casual  reference  to 

"I.  C.  C.  vs.  Alabama  Midland  Ry.  Co.,  i68  U.  S.,  144. 
"The  Chattanooga  Case,  I.  C.  C.  Reports,  X,  p.  in. 


Railway  Freight  Rates.  13 

this  fundamental  principle  in  connection  with  the  judicial  deter- 
mination of  cases  of  the  most  vital  importance  to  the  railways 
and  their  patrons.  The  commissions  seem  to  have  invented  and 
applied  in  many  cases  a  new  principle  of  rate-making  which  for 
want  of  a  better  name  may  be  designated  "What  the  railway 
officials  will  bear."  In  other  cases  they  have  acted  as  a  board  of 
arbitration  between  the  railways  and  the  shippers.^®  The  orders 
made  often  have  the  appearance  of  a  compromise,  without  any 
adequate  investigation  into  the  merits  of  the  case.  The  remark 
of  Commissioner  Prouty  in  the  Danville,  Va.,  case  is  an  excellent 
illustration  of  the  views  of  the  various  commissions  when  dealing 
with  important  rate  questions :  "It  is  impossible  to  apply  to  the 
solution  any  definite  rule.  Each  case  has  to  be  considered  upon 
its  own  peculiar  facts.  It  is  difficult  in  every  case  to  determine 
what  ought  to  be  done  in  justice  to  the  public  and  to  the  carrier, 
and  it  is  even  more  difficult  to  state  the  reasons  for  that  deter- 
mination."^^ 

(2)  By  the  Hepburn  amendment  to  the  Interstate  Commerce 
Act  the  Commission  was,  in  addition  to  its  former  powers, 
authorized  and  empowered  to  prescribe  a  system  of  accounts,  and 
upon  complaint  and  after  a  hearing,  to  establish  a  maximum  rate 
which  it  should  be  lawful  thereafter  for  the  railways  to  charge. 
In  accordance  with  the  first  provision  the  Commission,  under  the 
immediate  direction  of  Professor  Henry  C.  Adams  and  with  the 
active  cooperation  of  the  American  Railway  Association  and  the 
Association  of  American  Railway  Accountants,  has  prescribed  a 
system  of  accounts  giving  in  detail  the  classification  of  operating 
expenses,  revenues  and  expenditures  for  road  and  equipment,  and 
also  locomotive  miles,  car  miles,  and  train  miles.  This  system  of 
accounting  is  exceedingly  well  adapted  to  the  purpose  which  the 
Commission  apparently  had  in  mind,  i.  e.,  the  comparison  of 
expenses  and  revenues  of  the  same  general  nature  on  the  various 
lines  of  railways  in  the  United  States.  It  is  not,  however,  partic- 
ularly well  adapted  to  finding  the  cost  of  the  service ;  thus  while 

"Prouty,  a  commissioner,  observed  in  one  case:  "Probably  the  true  solu- 
tion of  this  controversy  is  to  be  found  in  a  mesne  between  the  contentions 
of  the  two  parties,"  thus  virtually  assuming  that  both  must  be  wrong. 
I.  C.  C.  Reports,  VII,  p.  458. 

"  I.  C.  C.  Reports,  VIII,  p.  409-442. 


14  Yale  Review. 

passenger  and  freight  revenue  is  kept  separate,  there  is  no 
particular  attempt  made  to  keep  the  expenses  of  these  depart- 
ments separate  according  to  sources.  Moreover,  no  consideration 
is  given  to  the  problems  of  fundamental  importance  in  determin- 
ing the  cost  of  passenger  or  freight  traffic  or  classes  of  freight 
traffic,  namely,  how  the  common  expenses  shall  be  pro-rated 
between  the  several  departments  and  how  both  the  revenue  and 
expenses  shall  be  apportioned  among  States.  Such  being  the 
case,  it  is  perhaps  hardly  to  be  expected  that  the  Interstate  Com- 
merce Commission  in  determining  the  reasonableness  of  par- 
ticular rates  should  give  much  attention  to  the  cost  of  the  service. 
Notwithstanding  this  fact,  it  is  desirable  to  examine  briefly  into 
the  Commission's  method  of  procedure  when  a  cost  method  is 
absolutely  necessary  to  make  a  decision  anything  more  than  a 
guess. 

The  Commission  has,  on  many  occasions,  asserted  that  "there 
is  no  standard  by  which  either  the  cost  of  the  service  or  the 
reasonableness  of  these  rates  can  be  fixed  with  any  certainty.  "^^ 
It  has  on  several  occasions  stated  that  elaborate  computations 
were  offered  in  evidence  by  the  railroads,^^  but  it  does  not  appear 
from  an  examination  of  the  cases  that  the  Commission  has  either 
scrutinized  the  correctness  of  the  railroads'  method  of  apportion- 
ment of  common  expenses  or  made  any  computations  of  this 
character  for  their  own  information.  Indeed,  the  Commission 
apparently  gives  very  little  weight  to  such  methods,  and  in  one 
case  distinctly  rejects  the  cost  of  the  service  for  any  particular 
commodity  as  a  just  or  proper  basis  of  the  reasonableness  of  the 
rate. 2*  In  fact,  it  has  definitely  stated  that  "where  particular 
rates  on  a  particular  commodity  between  particular  points  are 
challenged,  the  question  of  net  earnings  on  the  particular  lines 
involved  is  not  so  important  unless  it  be  shown  that  the  margin 

•*  The  Creamery  Cases,  Opinion  969,  I-  C.  C.  Reports,  p.  132 ;  also  Kindel 
vs.  Express  Company,  April  14,  1908,  p.  496;  Opinion  698,  p.  503;  Opinion 
760,  p.  57;    Opinion  809,  p.  319;   Opinion  874,  p.  17. 

"  Opinion  698,  p.  53 ;   Opinion  809,  p.  319  et  seq. 

"Opinion  874,  p. '17.  "To  divide  the  system  into  its  constituent  elements 
and  to  require  that  each  shall  show  a  surplus  commensurate  with  that  yielded 
by  the  business  of  the  system  as  a  whole  in  justification  of  a  particular  rate 
on  one  commodity  is  not  the  usual,  and  it  is  not  believed  to  be  the  proper, 
basis  upon  which  to  measure  the  justness  of  such  rate." 


Railway  Freight  Rates.  15 

of  profit  is  so  small  on  the  system's  business  as  a  whole  that  a 
reduction  in  the  particular  rates  would  reduce  the  whole  income 
below  the  reasonable  profit  point."  In  short,  when  the  earnings 
are  more  than  sufficient  to  pay  a  reasonable  return  upon  the 
investment  as  a  whole,  the  Commission  will  reduce  any  rate  that 
seems  to  be  out  of  harmony  with  the  rate  system  in  general  with- 
out regard  to  the  profitableness  or  unprofitableness  of  this 
particular  class  of  traffic.  This  attitude  of  the  Commission  appar- 
ently explains  the  fact  that  almost  without  exception,  when  rate 
questions  are  involved,  the  Commission  uses  the  comparative 
method  of  determining  the  proper  rate. 

While  the  Commission  gives  great  weight  to  the  influence  of 
competitive  conditions  in  the  adjustment  of  rates,  it  does  not 
believe  that,  because  low  rates  are  brought  about  in'  this  way, 
high  rates  on  other  parts  of  a  railroad  are  necessarily  justified; 
nor  is  a  high  local  rate  approved  because  of  a  low  proportional 
rate  on  shipments  through  the  same  point.^^  Again,  the  Com- 
mission will  not  accept  it  as  conclusive  argumentation  that  because 
rates  are  low  over  one  line,  they  therefore  ought  to  be  low  over 
every  other  line;  nor  does  a  voluntary  reduction  in  rates  prove 
that  the  former  rates  were  unreasonably  high.  The  Commission 
approves  of  the  policy  generally  adopted  by  railroads  of  extend- 
ing the  competitive  area  of  manufacturers  by  making  rates  to 
distant  points  relatively  lower  than  to  near-by  points^^ ;  and  within 
certain  limitations  the  railroad  may  consider  the  conditions  under 
which  the  industries  on  its  line  and  in  the  same  general  territory 
with  other  industries  are  conducting  their  business.^^  The  Com- 
mission also  holds  that  it  is  proper  to  make  rates  in  proportion 
to  the  value  of  the  goods,  giving  low  cost  goods  low  rates  and 
goods  of  higher  commercial  value  higher  rates ;  it  also  expresses 
the  opinion  that  the  most  satisfactory  comparison  available  to 
ascertain  whether  a  relative  injustice  is  being  done  one  section  as 
against  another  or  one  commodity  as  against  another,  is  through 
the  earnings  per  car.^^ 

**  Opinion  874,  p.  16. 

"Opinion  875,  p.  24;    Opinion  919,  p.  203. 

*' Opinion  875,  p.  24. 

"Opinion  895,  p.  114. 


1 6  Yale  Review. 

Notwithstanding  this  evident  disregard  of  the  cost  of  the 
service  principle,  the  Commission,  since  it  was  definitely 
empowered  to  fix  rates,  has  been  giving  more  attention  to  the 
cost  of  transportation,  although  in  a  very  general  way  and  with- 
out the  application  of  scientific  accounting  principles.  This 
movement  has  in  some  cases  been  introduced  by  the  railroads  in 
self-protection ;  for  example,  when  certain  ice  companies  brought 
an  action  before  the  Commission  to  secure  a  reduction  of  rates 
on  ice  transported  over  the  Erie  and  the  Delaware,  Lackawanna  & 
Western  from  points  in  New  York  and  Pennsylvania  to  the  New 
York  and  Philadelphia  markets,  the  railroads  introduced  accounts 
for  the  purpose  of  showing  that  this  service  was  being  conducted 
at  only  a  little  above  its  actual  cost,  and  that  therefore  the  reduc- 
tion of  rates  would  cause  an  actual  loss.^®  The  Erie  Railroad 
Company  presented  data  showing,  according  to  their  method  of 
distributing  expenses,  that  the  cost  of  the  ice  service  over  a 
particular  line  for  the  season  was  as  follows:  maintenance  of 
way,  $3,000;  maintenance  of  equipment,  $7,000;  transportation 
expenses,  $5,000.^^  The  Commission  in  examining  this  state- 
ment observed  that,  according  to  the  figures  presented  by  the  Erie 
Railroad  Company,  the  cost  of  the  maintenance  of  way  amounted 
to  20  per  cent.,  maintenance  of  equipment  to  46^  per  cent,  and 
transportation  expenses  to  only  33 >^  per  cent,  as  compared  with 
18  per  cent.,  29  per  cent,  and  48  per  cent,  for  these  items  respec- 
tively for  the  whole  railroad.  The  Commission  held  that  the 
cost  of  maintenance  of  way  in  the  ice  service  was  fixed  too  high 
because  it  was  computed  upon  a  mileage  basis  while  the  trains 
were  comparatively  light  and  also  since  "this  [expense]  must 
have  been  incurred  almost  or  quite  in  toto  if  this  ice  train  had 
not  run."  The  Commission  also  thought  the  cost  of  maintaining 
equipment  higher  than  it  ought  to  be  on  the  ground  that  part  of 
the  expenses  was  estimated  and  the  "basis  of  the  estimate  is  mani- 
festly wrong";  it  does  not,  however,  state  its  reasons  for  so 
thinking.     The  Commission,  therefore,  concludes  that  the  fair 

"  Opinion  809,  p.  316. 

"In  addition  to  the  above  expenses  there  was  a  haul  of  over  four  miles 
from  another  branch  line  not  included  and  the  terminal  expense  at  Jersey 
City  was  not  stated. 


Railway  Freight  Rates.  17 

cost  of  doing  this  business  under  normal  conditions  would  not 
exceed  $10,000,  and  therefore  a  small  reduction  in  rates  would 
not  render  the  business  unprofitable.  The  method  used  by  the 
Lackawanna  Railroad  Company  was  somewhat  more  scientific. 
The  actual  movement  expenses  of  a  train  of  thirty  cars,  empty 
one  way,  was  found  for  the  round  trip ;  the  "indirect  line  cost" 
per  car  was  computed  by  distributing  expenses  between  the 
passenger  and  freight  departments,  and  then  the  average  cost  per 
ton-mile  was  calculated  for  the  whole  road.  The  cost  of  the  ice 
business  was  then  computed  per  car  and  an  arbitrary  added 
because  the  empty  car  movement  was  greater  in  this  business  than 
the  average  for  the  system.  The  terminal  expenses  were  found 
by  dividing  the  total  freight  terminal  expenses  by  the  number  of 
cars  handled.  By  this  method  the  movement  expenses  were 
found  to  be  $2.29  per  car,  indirect  line  expenses  $9.63,  indirect 
terminal  expenses  $7.28.  To  this  was  added  the  sum  of  $0.35  per 
car  on  account  of  the  extraordinary  cost  of  maintaining  ice  cars. 
The  total  cost  per  car  for  the  round  trip  was  thus  found  to  be 
$19.55,  while  the  revenue,  $0.85  per  ton,  amounted  to  $22.95, 
leaving  a  profit  per  car  of  $3.40.  The  Commission  rejected  the 
cost  accounting  submitted  by  the  Lackawanna  Railroad  Company 
chiefly  on  the  ground  that  there  is  no  warrant  for  the  assump- 
tion that  either  the  indirect  line  expense  or  the  indirect  terminal 
expense  per  car  was  as  great  as  it  was  for  the  average  traffic. 
"On  what  theory,"  it  asks,  "can  it  be  assumed  that  the  traffic 
shall  pay  in  proportion  to  the  number  of  tons  exactly  the  same 
contribution  to  the  fixed  charges  that  all  other  traffic  pays?"  It 
therefore  concluded  that,  since  there  was  a  wide  margin  between 
the  movement  cost  of  $19.55  P^^  car  and  the  revenue  $22.95  P^^ 
car,  there  was  little  doubt  that  the  rates  might  be  materially 
reduced  and  still  leave  a  fair  profit. 

In  all  of  the  cases  decided  by  the  Commission  previous  to 
February  9,  1909,  even  where  the  cost  of  the  service  was  con- 
sidered, that  factor  was  an  unimportant  element  in  its  effect  upon 
the  decision.  That  is,  the  cases  were  decided  with  reference  to 
the  "general  situation,"  taking  into  account  all  factors — the 
competition  of  railroads,  of  commodities,  markets,  etc.,  etc.  In 
the  Spokane  case  three  questions  were  raised,  namely : 


1 8  Yale  Review. 

First.  Do  the  rates  of  the  defendants  unduly  discriminate  against  Spokane 
in  favor  of  coast  points?  This  includes  the  further  inquiry  whether  these 
rates  are  in  violation  of  the  fourth  section. 

Second.  Do  the  defendants  improperly  allow  certain  privileges  to  coast 
traffic  which  are  denied  Spokane,  like  the  mixing  of  carloads,  lighter 
minimimis,  etc? 

Third.  Are  the  rates  applied  by  the  defendants  to  Spokane  inherently 
tmjust  and  imreasonable?*^ 

After  a  review  of  the  facts  and  the  law  the  Commission  decided 
that  in  the  first  and  second  issues  Spokane  had  no  cause  for 
complaint.  The  real  question,  it  was  stated,  was  as  follows :  Are 
the  rates  unjust  and  unreasonable  in  themselves  under  the  first 
section  of  the  act?  In  the  determination  of  this  question,  the 
Commission  accepted  without  discussion  the  general  principle  that 
a  railroad  is  entitled  to  charge  rates  sufficiently  high  to  enable  it 
to  earn  a  fair  return  upon  its  investment.  In  applying  this 
principle  to  the  case,  two  subsidiary  questions  of  the  greatest 
moment  were  immediately  raised,  viz.:  (i)  May  the  rates  be 
reduced  to  a  point  where  only  that  line  whose  lowest  total 
operating  cost  is  the  lowest  may  earn  a  fair  return  upon  its 
investment,  or  must  the  rates  be  sufficiently  high  so  that  the  road 
least  favorably  situated  may  earn  a  living  F^^  After  citing  the 
Charles  River  Bridge  case  and  the  Brunswick  and  Topsham 
Water  cases  and  discussing  their  bearings  upon  this  case,  the 
Commission  decided  that  regard  must  be  had  not  altogether  to 
any  one  particular  railroad,  but  to  the  "whole  situation, "^^  and 
therefore  they  considered  the  effect  of  their  proposed  order  upon 
all  the  railroads  directly  interested.  It  was  further  inquired: 
(2)  What  is  the  value  of  the  investments  upon  which  the  rail- 
roads are  individually  to  be  permitted  to  earn  a  fair  return? 
After  quoting  in  full  the  principles  laid  down  by  the  court  in 

"  City  of  Spokane,  et  al.  vs.  N.  P.  Ry.  Co.  et  al,  I.  C.  C  Reports,  Opinion 
820. 

"  In  this  case,  it  was  argued  that  the  Northern  Pacific  was  a  more  expen- 
sive road  to  build  and  operate  than  the  Great  Northern.  Consequently,  if 
rates  were  forced  down  to  a  point  where  the  Great  Northern  could  earn 
only  a  fair  return  upon  its  investment,  the  Northern  Pacific,  since  it  would 
have  to  observe  the  same  rates  of  fare  on  its  through  business,  would  be 
bankrupted.    Opinion  820,  p.  391-2. 

"Opinion  820,  p.  .394.  This  opinion  was  in  accordance  with  a  previous 
opinion  foimd  in  9  I.  C.  C.  Reports,  p.  382. 


Railway  Freight  Rates.  19 

Smith  vs.  Ames,'*  it  was  stated  that  the  Commission  had  certain 
information  more  or  less  complete  on  the  following  points :  (a) 
an  estimate  of  the  cost  of  reproducing  both  the  Northern  Pacific 
and  the  Great  Northern  railways ;  (b)  some  information  as  to  the 
actual  cost  of  each;  (c)  the  present  capitalization  of  each;  and 
(d)  the  gross  and  net  earnings  for  a  series  of  years  for  both 
roads,  together  with  the  estimated  reduction  in  the  earnings  for 
the  same  amount  of  traffic  under  the  proposed  rates. 

Each  railroad  submitted  a  detailed  statement  of  the  grading, 
tunnels,  bridges,  culverts,  rails,  ties,  and  the  other  items  of  con- 
struction, together  with  the  amount  of  land  used  and  the  entire 
equipment ;  and  applying  present  day  prices,  it  was  found  that  the 
cost  of  the  Northern  Pacific  and  Great  Northern  was  each 
approximately  four  hundred  million  dollars.  These  estimates 
were  submitted  to  Mr.  Gillette,  the  engineer  of  the  Washington 
State  Railway  Commission,  who  reduced  the  cost  of  construction 
items  by  $69,ooo,cxx)  for  the  Northern  Pacific  and  by  $80,000,000 
for  the  Great  Northern.  The  Commission,  in  reviewing  these 
estimates,  made  the  wise  but  somewhat  trite  observation  that  "as 
usual,  the  truth  undoubtedly  lies  somewhere  between  these  rather 
wide  limits. "^'^ 

The  Commission  then  reviewed  the  evidence  submitted  by  the 
railroads  showing  the  cost  of  original  construction,  but  on 
examination  of  this  evidence  found  that  the  books  and  records 
had  been  so  inaccurately  kept  that  no  reliance  could  be  given  to 
this  data.  The  capitalization,  it  was  found,  had  little  relationship 
to  either  cost  or  value,  and  this  criterion  was  therefore  abandoned 
as  showing  the  value  of  the  investment.  Even  in  its  attempts  to 
find  the  earnings  of  the  two  railroads  for  a  series  of  years,  the 
Commission  was  far  from  successful.  It  was  found  that  for  the 
past  ten  years  in  the  case  of  the  Northern  Pacific  and  since  1891 
for  the  Great  Northern,  interest  on  all  of  the  bonds  issued  and 
dividends  on  the  stock  had  been  regularly  paid.  In  addition  each 
railroad  had  accumulated  in  the  form  of  surplus  and  permanent 

•*  Smith  vs.  Ames,  169  U.  S.,  466. 
"Opinion  820,  p.  396. 


20  Yale  Review. 

improvements  taken  from  earnings  over  fifty  million  dollars.'® 
The  statement  of  earnings  as  presented  was  further  complicated 
by  the  fact  that  both  the  Great  Northern  and  the  Northern  Pacific 
either  directly  or  through  subsidiary  companies  owned  valuable 
coal  and  iron  mines.  In  the  case  of  the  Northern  Pacific,  coal  was 
sold  both  to  the  railroad  company  and  to  the  public  at  a  price 
which  enabled  the  subsidiary  company  to  pay  interest  upon  its 
$7,cxx),ooo  of  bonds  and  a  dividend  of  629  per  cent,  upon  its 
capital  stock  of  $2,775,000,  giving  the  Northern  Pacific  stock- 
holders an  extra  dividend  of  $11.26  per  share.^'^ 

On  the  data  substantially  as  presented  in  the  brief  outline  given 
above,  the  Commission  held  that  while  it  was  both  legally  neces- 
sary and  economically  advisable  to  permit  rates  that  would  attract 
capital  to  invest  in  railway  securities,  both  railroads  had  been 
earning  at  an  excessive  rate  and  therefore  it  was  decided  that  a 
reduction  of  rates  to  Spokane  should  be  ordered.  To  further 
substantiate  its  conclusions  the  Commission  presented  a  number  of 
tabulations  showing  the  rates  for  similar  commodities  for 
approximately  the  same  distances  in  other  parts  of  the  United 
States. 

The  Commission,  it  should  properly  be  added,  appreciated  the 
fact  that  its  methods  were  unscientific  and  therefore  unsatisfac- 
tory; it  was  stated  at  one  point  that  "there  is  no  absolute  test 
of  a  reasonable  rate  and  the  government  has  supplied  none."^^ 
It  might  have  added  with  very  great  propriety  the  following  pro- 
position, viz. :  The  Interstate  Commerce  Commission  was  created 
for  the  purpose  of  considering  in  a  reasonable  and  intelligent  way 
the  very  question  which  it  here  confessed  had  not  yet  been  solved. 
It  is  to  be  hoped  that  following  the  inauguration  of  a  systematic 
and  comprehensive  system  of  accounts  for  all  the  railroads  in  the 
United  States,  the  Commission  will  give  less  attention  to  legal 

"•The  data  presented  in  the  opinion  of  the  Commission  is  so  meager  that 
it  is  impossible  properly  to  interpret  the  actual  conditions  as  to  the  net 
earnings  of  either  road.  It  is,  of  course,  necessary  to  present  a  balance  sheet 
as  well  as  a  statement  of  earnings  in  order  to  determine  the  true  financial 
status  of  a  railroad  company.  In  this  case  a  very  incomplete  statement  of 
earnings  alone  was  presented  by  the  Commission. 

"  Opinion  820,  p.  97. 

••  Opinion  820,  p.  416. 


Railway  Freight  Rates.  21 

precedent  and  more  to  the  principles  of  economics  and  of  account- 
ancy, and  thus  of  its  own  motion  inaugurate  a  reasonable  test  of 
a  reasonable  rate.^^ 


IV. 

The  Wisconsin  Railway  Commission  was  the  first  to  break 
away  from  the  unscientific  method  which  has  been  employed  by 
the  Interstate  Commerce  Commission  since  it  began  its  work  in 
1887  and  by  all  of  the  other  State  commissions.  The  Wisconsin 
Commission  has  therefore  been  obliged  to  blaze  a  new  path 
through  the  wilderness  of  conflicting  methods  of  accounting  and 
of  theories  of  railway  rates.  It  fortunately  began  to  apply  its 
theories  and  methods  in  passenger  rate  cases  where  the  condi- 
tions are  simpler  and  where,  therefore,  the  principles  are  more 
easily  applied.  Having  begun  thus  fortunately,  and  also  scien- 
tifically, and  finding  that  it  was  possible  to  introduce  system 
where  chaos  formerly  reigned  supreme,  it  was  a  foregone  con- 
clusion that  the  Commission  would  make  the  attempt  to  introduce 
the  same  scientific  methods  into  the  determination  of  freight-rate 
cases.  Indeed,  in  one  of  the  first  cases  on  freight  rates  which 
came  before  it  for  decision,  the  general  principles  upon  which  the 
Commission  has  since  acted  were  stated  as  follows:  "We  think 
it  a  basic  principle  that  all  persons  desiring  to  use  the  quasi  public 
highways  of  our  country  should  be  accorded  the  privilege  of 
doing  so  on  payment  of  a  reasonable  compensation  for  the  service 
performed  and  that  no  greater  compensation  should  be  exacted 
from  one  than  from  another  for  a  like  service.  ...  It  seems  to 
us  to  be  alien  to  the  purpose  of  a  Public  Service  Corporation  to 
refuse  to  abide  by  this  principle  and  to  dictate  who  shall  and  who 
shall  not  do  business  on  its  line  of  road."*® 

In  its  first  attempts  to  apply  these  general  principles  to  specific 
cases,  the  Railroad  Commission  of  Wisconsin  gave  considerable 
attention  to  relative  rates,  making  elaborate  comparisons  between 

**In  a  still  later  opinion,  No.  874,  rendered  April  12,  1909,  the  Commission 
further  considered  the  accounting  problem  involved  in  the  determination  of 
freight  rates  on  the  basis  of  the  cost  of  the  service,  with  the  same 
unsatisfactory  result. 

•"'Reports  of  the  Wisconsin  Railway  Commission,"  Vol.  I,  p.  88. 


22  Yale  Review. 

the  rates  for  the  same  class  of  traffic  in  Wisconsin  and  in  the 
neighboring  States  where  traffic  and  operating  conditions  were 
fairly  similar,  and  also  between  different  railroads  in  Wisconsin. 
The  more  elaborate  the  comparisons  became,  the  more  dissatisfied 
the  Commission  seems  to  have  felt  with  this  method  as  a  final 
solution.  More  and  more  the  Commission  turned  to  a  study  of 
the  real  cost  of  the  service,*^  and  in  order  to  use  this  method  of 
determination,  it  was  found  necessary  to  consider  the  various 
plans  for  apportioning  common  or  joint  expenses  among  classes 
of  freight  traffic  by  a  process  entirely  similar  in  its  general 
principles  to  that  pursued  in  separating  the  common  expenses 
between  the  freight  and  passenger  departments.  This  situation 
is  well  illustrated  in  the  sugar  rate  cases.^^  After  an  extended 
discussion  of  the  relation  of  the  sugar  rate  to  other  rates  of  the 
same  general  character,  and  to  the  cost  of  this  particular  service 
in  comparison  with  other  branches,  the  Commission  suddenly 
turned  to  a  consideration  of  the  cost  actually  incurred  and  finally 
decided  the  case  upon  the  cost  basis.^^  It  is  unfortunate  from  the 
scientific  point  of  view  that  the  Commission  nowhere  states  the 

*^"But,  as  already  alluded  to,  rate  comparisons  do  not  often  constitute 
sufficient  evidence  upon  which  to  decide  cases  of  this  character.  Other  facts, 
in  addition  to  the  rates,  are  usually  required  for  a  full  understanding  of  the 
question  at  issue.  While  the  kind  of  the  evidence  that  may  be  needed  will 
necessarily  vary  with  the  character  of  the  questions  that  are  involved,  there 
is  one  class  of  data  that  is  of  the  greatest  importance  whenever  the  reason- 
ableness of  the  rates  is  questioned,  and  that  is,  such  facts  as  will  tend,  at 
least,  to  show  the  approximate  cost  to  the  carriers  of  performing  the  services 
in  question."  Decision  58,  p.  9.  See  also  Chippewa  Sugar  Company  vs. 
Railway  Companies,  Decision  29,  p.  24. 

*"  Chippewa  Sugar  Company  vs.  Railway  Companies,  Decision  29. 

^  "But  important  as  the  facts  which  have  thus  been  examined  may  be,  they 
are  not  the  only  ones  upon  which  we  may  base  our  decision  in  this  case. 
For  the  purpose  of  obtaining  more  definite  information  concerning  both  the 
units  of  transportation  and  units  of  service  we  have  carefully  analyzed  the 
operating  expenses  of  the  roads.  We  have  endeavored  to  fairly  apportion 
these  expenses  between  the  different  classes  of  traffic  and  to  find  some  trust- 
worthy methods  upon  which  they  might  be  properly  separated  between 
terminal  and  movement  expenses,  and  also  by  which  both  the  terminal  and 
the  movement  expenses  may  be  equitably  adjusted  according  to  kind  and 
volume  of  the  traffic.  We  have  also  endeavored  to  ascertain  the  difference 
in  the  cost  between  the  local  and  through  traffic,  and  to  find  some  basis  upon 
which  the  movement  expenses  can  be  so  adjusted  that  each  of  these  classes 
of  traffic  is  adequately  provided  for."    Decision  29,  p.  24. 


Railway  Freight  Rates.  23 

exact  process  which  it  has  adopted  for  pro-rating  the  expenses 
between  different  classes  of  freight  traffic.  It  is  clear,  however, 
that  the  terminal  expenses  per  carload  are  first  found,  that  then 
the  movement  expenses  are  determined  by  assigning  the  actual 
expenditures  so  far  as  possible  to  particular  classes  of  traffic,  and 
that  then  the  common  expenses  are  apportioned  separately  for  each 
class,  different  criteria  being  employed  in  each  case.^^  In  a 
general  way  the  complete  process  adopted  by  the  Wisconsin  Com- 
mission is  given  in  outline  in  the  case  "In  re  Rates  on  Pulp 
Wood."  Since  the  method  is  stated  in  its  barest  outlines,  the 
statement  is  here  given  in  full : 

To  determine  even  the  approximate  cost  per  unit  of  transportation  to  the 
carriers  is  very  difficult,  and  can  only  be  done  through  series  of  long  and 
complicated  calculations,  most  of  which  have  been  explained  in  former  deci- 
sions. The  first  step  necessarily  involves  a  separation  of  the  expenses 
between  the  different  branches  of  traffic.  Complicated  as  this  is,  it  is  yet 
our  judgment  that  it  can  be  accomplished  with  a  fair  degree  of  accuracy  and 
in  a  manner  that  is  fair  to  all  concerned.  The  next  step  is  to  separate  the 
expenses  on  the  basis  of  which  the  traffic  is  handled,  that  is,  between  the 
cost  of  handling  the  traffic  at  the  terminal  and  the  cost  of  moving  it  between 
the  terminals.  In  this  case,  as  in  the  case  of  separating  the  expenses  between 
the  different  branches  of  traffic,  many  items  are  met  with  which  are  common 
to  both  sides  and  which  do  not  readily  admit  of  exact  distribution.  But 
even  these  difficulties  may  be  overcome.  Upon  close  and  detailed  examina- 
tions of  the  various  factors  involved,  some  way  can  usually  be  found  in 
which  the  common  items  can  be  fairly  and  equitably  assigned.  This  is  not  a 
matter  of  opinion  merely,  but  has  been  shown  to  be  so  in  actual  practice. 
The  next  step  consists  of  finding  some  units  upon  which  the  various  classes 
of  these  expenses,  or  the  terminal  and  the  movement  costs,  can  be  pro-rated, 
and  the  gross  and  net  cost  per  any  given  quantity  of  the  traffic  be  determined. 
The  best  units  for  this  purpose  would  seem  to  be  the  loaded  car.  This  must 
necessarily  be  so  since  freight  is  usually  handled  and  moved  in  carloads. 
The  terminal  costs,  for  instance,  may  be  pro-rated  on  the  number  of  these 
cars  and  the  movement  expenses  on  their  mileage. 

**  "Without  going  into  details,  which  is  impracticable  here,  it  can  be  said 
that  through  the  re-classification  and  re-arrangement  of  a  large  part  of  the 
operating  expenses  and  by  obtaining  a  great  deal  of  operating  and  traffic 
data,  in  addition  to  the  statistics  which  are  usually  found  in  the  reports  of 
the  roads,  we  are  able  to  ascertain  the  approximate  cost  per  unit  of  trans- 
portation of  both  the  terminal  and  movement  expenses  for  lighter  as  well 
as  for  heavier  carloads  and  for  the  way  freight  as  well  as  the  through  haul. 
With  the  assistance  of  the  classifications  and  tariffs  now  in  effect  a  basis 
has  also  been  developed  upon  which  these  costs  may  be  adjusted  according 
to  the  value  of  the  products  with  a  fair  degree  of  accuracy."  Decision  59, 
P-  30. 


24  Yale  Review. 

When  the  cost  per  car  in  turn  for  terminal  expenses  is  pro-rated  upon 
the  freight  in  the  car  the  amount  of  these  expenses  to  each  unit  of  the  traffic 
is  obtained.  When  the  cost  per  loaded  car  per  mile  is  pro-rated  on  the 
weight  of  both  the  car  and  the  load  the  average  cost  per  gross  ton  per  mile 
of  haul  is  found.  This  cost  per  gross  ton,  or  other  unit,  can  be  used  as  the 
basis  upon  which  the  movement  expenses  per  net  ton  or  other  unit  is  com- 
puted Under  these  methods  it  is  possible  to  determine  the  average  cost  per 
net  unit  of  traffic  of  handling  the  freight  at  the  terminals,  as  well  as  of 
moving  it  between  the  terminals.  Furthermore  it  is  possible  from  the  data 
as  a  whole  to  ascertain  these  costs  under  various  kinds  of  loading  or  for 
lighter  as  well  as  for  heavier  loading. 

The  fourth  step  involves  such  an  adjustment  of  these  costs  as  to  apply 
to  local  as  well  as  through  business.  In  these  operations,  however,  the 
terminal  expenses  are  not  involved.  It  is  perfectly  clear  that  these  costs 
have  no  relation  to  the  length  of  the  haul.  They  appear  to  be  as  great  for 
a  carload  going  a  hundred  miles  as  for  one  going  five  hundred  miles.  The 
movement  costs,  however,  vary  with  the  distance  and  not  far  from  in  the 
same  proportion.  But  the  cost  of  handling  way  freight  which  makes  fre- 
quent stops  and  slow  time,  is  relatively  much  greater  than  the  cost  for 
through  freight  or  traffic  which  is  moved  through  from  one  place  to  another 
on  faster  schedules.  To  determine  the  difference  in  the  cost  as  between 
through  and  local  traffic,  like  all  other  apportionments  of  expenses,  is  far 
from  an  easy  matter,  but  under  a  complete  analysis  of  both  the  expenses 
and  operating  conditions,  it  can  be  done  in  a  manner  that  would  seem  to  be 

fair  all  around. 

In  this  manner  it  is  possible  to  obtain  approximately  correct  ideas  of  the 
cost  per  unit  to  the  carrier  for  handling  the  traffic.  This  cost  is  undoubtedly 
the  most  important  element  in  rate  making.  This  is  particularly  true  since 
it  is  possible  to  ascertain  the  same  for  less  than  carload  as  well  as  for 
carloads  or  for  both  smaller  and  larger  shipments.  The  value  of  products 
is  an  client  that  in  importance  in  this  respect  is  second  only  to  the  cost 
As  already  pointed  out,  articles  of  high  value  can  fairly  bear  higher  rates 
than  low  priced  ones,  and  in  view  of  this  fact  it  is  only  just  that  the  charges 
levied  for  transportation  should  be  relatively  greater  in  the  former  case. 

It  will  be  noticed  that  the  system  adopted  by  the  Wisconsin 
Commission  provides  a  double  standard  of  reasonable  rates; 
first,  that  of  cost  of  service  and,  second,  that  of  the  value  of  the 
articles  transported.  In  regard  to  the  first,  there  can  be,  from  the 
theoretical  standpoint,  little  difference  of  opinion:  each  class 
of  traffic  should  pay  its  own  costs ;  in  other  words,  there  should 
be  no  parasites  on  the  freight  service  and  no  paupers  transported 
in  freight  cars.*«     The  real  difficulty  in  the  application  of  this 

•  Decision  89,  p.  57-  ,         ^    .j   .   •       1  •       .u« 

*"In   every   rate   case  which   we  have   heretofore   decided   involving  the 

reasonableness  of  the  rate  in  itself,  we  have  acted  upon  the  assumption  which 

we  regard  as  fundamental,  that  every  branch  of  the  railway  service  shall 


Railway  Freight  Rates.  25 

principle  is  found  in  the  method  of  keeping  accounts  and  the 
absence  of  any  absolute  standard  for  distributing  the  common 
expenses.  The  method  used  by  the  Wisconsin  Commission  seems 
to  be  worked  out  upon  a  sound  basis  and  to  be  sufficiently  accurate 
for  the  purposes  for  which  it  is  intended.  It  is,  however,  impos- 
sible to  judge  of  this  latter  point  in  the  absence  of  more  detailed 
information  as  to  its  practical  application  in  specific  cases. 

The  cost  basis  is,  however,  modified  in  its  application  by  the 
Wisconsin  Commission  in  accordance  with  the  commercial  value 
of  the  goods  transported.  This  practice,  if  it  can  be  justified  at 
all,  must  be  justified  upon  one  or  both  of  the  following  grounds : 
First,  that  the  risks  are  greater  in  case  of  loss  or  damage  and  the 
care  demanded  in  the  transportation  of  valuable  goods  is  thereby 
increased.  Since  loss,  damage,  and  care  in  shipment  are  elements 
in  the  actual  cost  of  transportation  and  show  themselves  in  the 
greater  cost  of  carriage  of  the  more  valuable  goods,  this  method 
of  justification  must  of  course  be  rejected  wherever  the  real  costs 
of  transportation  have  been  accurately  determined.  Again,  the 
more  valuable  goods,  it  is  said,  are  able  to  bear  a  relatively  higher 
rate.  The  consideration  of  this  theory,  which  has  become  a 
classic  in  the  American  railway  system  of  rates  and  is  even  openly 
approved  by  the  Wisconsin  Commission,  the  protagonist  in  the 
use  of  the  cost  of  the  service  standard,  is  so  involved  from  the 
economic  standpoint  that  a  brief  and  somewhat  tentative  state- 
ment only  will  be  attempted  here.  It  is  of  course  obvious  that 
the  added  cost  of  transportation  for  the  more  valuable  goods  will 
fall  either  upon  the  producer  of  the  goods  or  upon  the  consumer, 
or  will  be  shared  by  the  two  parties.  It  is  also  obvious  that  the 
higher  price  of  transportation  will  further  limit  the  use  of  the 

pay  its  own  way  and  that  every  class  of  traffic  within  each  branch  shall,  as 
far  as  commercial  and  competitive  conditions  permit,  stand  on  its  own 
bottom.  While,  technically,  the  law,  as  interpreted  by  the  court  up  to  the 
present  moment,  may  not  require  this  in  all  cases,  we  are  convinced  that  the 
spirit  of  the  law  ddes  require  it.  Equity  positively  demands  it  and  rational 
social  and  economic  theory  supports  it.  In  the  case  under  consideration  car- 
load freight  is  made  to  bear  the  total  expense  of  carrying  not  only  less  than 
carload  freight,  but  also  of  passengers.  We  do  not  know  how  great  this 
expense  is;  the  amount  of  it  is  immaterial.  In  our  judgment  such  a  prac- 
tice on  the  part  of  a  common  carrier  is  unlawful,  inequitable,  and  economi- 
cally and  socially  parasitic."    Decision  60,  p.  g. 


26  Yale  Review. 

goods  and  to  this  extent  diminish  the  amount  offered  for  trans- 
portation. Wherever  an  economic  society  is  made  up  of  indi- 
viduals of  approximately  equal  wealth,  the  more  valuable  goods 
are  either  those  whose  quantity  is  strictly  limited  by  nature  and 
which  may  or  may  not  be  capable  of  being  somewhat  more  freely 
produced,  or  those  which  answer  the  more  urgent  and  pressing 
wants  of  society.  In  either  case  it  would  be  a  distinct  economic 
gain  to  the  community  to  have  the  rate  of  transportation  low  upon 
such  goods.  In  a  community  composed  of  both  poor  and  wealthy 
classes,  the  situation  is  somewhat  different :  here  the  higher  priced 
goods  may  to  a  certain  extent  be  those  which  the  wealthy  wish  to 
use  for  immediate  personal  gratification  or  personal  vanity  and 
which  do  not  contribute  at  all  to  their  permanent  comfort  or 
well-being.  In  such  cases  the  higher  rate  of  transportation  falls 
as  a  tax  upon  the  producers  or  consumers  of  these  commodities 
according  as  the  production  is  monopolized  or  the  reverse.  Since 
most  modern  nations — those  in  which  railway  transportation  has 
become  general — have  developed  well-defined  wealthy  classes,  it 
is  evident  that  such  a  rate  system  is  likely  to  act  as  a  progressive 
tax  upon  such  classes  or  upon  the  more  prosperous  business  enter- 
prises. The  burden  of  the  higher  rate  will  fall  upon  the  producer 
or  consumer  according  to  the  degree  of  monopoly  power  pos- 
sessed by  the  producer.  In  a  perfect  competitive  society,  all 
goods  sell  in  the  market  at  their  cost  of  production:  if,  now,  in 
such  a  society,  any  railway  company  should  raise  its  rates  on  any 
group  of  commodities,  such  action  would  increase  the  cost  of 
production  of  the  goods  on  the  market,  the  price  would  necessarily 
rise,  the  quantity  of  goods  sold  would  be  lessened,  and  the  con- 
sumers would  contribute  to  the  railroad  companies  the  amount  of 
increase  on  each  unit  transported  and  sold.  No  perfect  competi- 
tive society  has  ever  existed,  nor  is  any  such  promised  in  the 
immediate  future;  goods  are  produced  and  sold  under  fierce 
competition,  under  restricted  competition,  and  under  partial  or 
almost  complete  monopoly.  When  goods  are  produced  under 
monopolistic  conditions,  the  producer  fixes  the  price  and  deter- 
mines the  amount  of  the  output  in  such  relation  that  his  net 
profits  are  at  a  maximum;  an  increase  in  freight  rates  cannot 
under  such  conditions  be  shifted  to  the  consumer  and  must  there- 
fore be  borne  by  the  producer.     When  the  production  of  goods 


Railway  Freight  Rates.  27 

is  partially  monopolized,  the  increased  cost  of  production  will  be 
shared  by  the  semi-monopolistic  producer  and  the  final  consumer. 
In  either  case  the  railroads  profit  at  the  expense  of  both  the  pro- 
ducer and  the  consumer  of  the  goods  in  question.**^ 

The  system  is  further  justified  from  the  economic  point  of  view 
on  the  ground  that  the  increased  revenue  from  the  more  valuable 
goods  enables  the  railroad  to  carry  low-priced  goods  at  less  than 
cost  where  each  class  of  traffic  is  charged  with  its  proportion  of 
the  fixed  expenses.  That  this  is  a  possible  situation  is  not  open 
to  question,  but  that  any  railroad  carries  low-class  traffic  at  rates 
less  than  competitive  or  industrial  conditions  make  necessary,  is 
not  probable.  However,  any  railroad  that  has  its  transportation 
facilities  only  partially  utilized  is  under  economic  pressure  to 
secure  more  traffic  from  whatever  source  possible;  higher  rates 
on  high-priced  goods  furnish  it  with  a  fighting  fund  which  is 
often  used  to  carry  on  a  traffic  war  with  a  neighboring  railroad. 
Under  normal  conditions,  the  railroad  with  the  lowest  cost  of 
transportation  will  finally  secure  the  competitive  traffic.  In  this 
case,  the  railroad  that  is  in  a  position  to  levy  a  tax  upon  the  pro- 
ducers and  consumers  of  the  more  highly  valued  goods  is  in  a 
position  to  conquer  or  subjugate  a  competitor  more  fitted  to 
survive  and  furnish  transportation  facilities  to  the  community, 
through  the  use  of  a  fund  taken  from  the  users  of  the  more  valu- 
able goods  without  rendering,  from  the  social  point  of  view,  an 
equivalent  for  it.  A  more  complete  and  searching  analysis  of 
this  situation  will  convince  the  student  of  general  social  welfare 
that  no  system  which  permits  a  railroad  company  to  secure  a 
large  surplus  revenue  from  the  goods  most  in  demand  by  the 
community  can  be  justified  from  the  larger  point  of  view.  This 
system  is,  however,  in  almost  universal  use,  is  sanctioned  by  the 
letter  of  the  law  of  the  land  as  interpreted  by  the  courts,  and  has 
therefore  become  an  integral  part  of  our  industrial  life.  Transi- 
tion from  it  to  the  cost  of  service  basis  ought  to  be  a  gradual  one ; 
but  in  the  interests  of  general  economic  welfare  of  the  future,  the 
transition  ought  to  be  made. 

"Wherever  the  consumer  bears  any  part  of  the  increased  rate,  the  sale 
of  the  goods  will  be  less  and  the  railroads  will  thus  lose  in  quantity  of 
freight  transported  while  gaining  in  the  rate.  Wherever  rates  can  be 
increased  without  decreasing  the  quantity  of  goods  transported  in  like  pro- 
portion, such  action  is  likely  to  be  taken. 


28  Yale  Review. 

V. 

It  has  been  assumed  in  the  discussion  thus  far,  though  without 
direct  proof,  that  rates  on  certain  classes  of  goods,  viz.,  local 
traffic  and  valuable  goods,  are  relatively  high.     It  will  be  noticed 
that,  unless  the  cost  of  the  service  can  be  found  with  reasonable 
accuracy,  any  assumption  of  this  sort  is  purely  hypothetical. 
The  Wisconsin  Railway  Commission  has  developed  a  system  that 
determines    the    approximate    cost,    but,    owing   to    established 
industrial  conditions,  has  not  attempted  to  apply  it  except  in  a 
modified  way.     The  cost  of  the  service  principle  is,  however,  of 
the  very  greatest  importance  to  the  railways  themselves.     Mr. 
Haines  calls  attention  to  this  fact  and  is  authority  for  the  state- 
ment that  the  railways  have  in  the  past  lost  millions  of  dollars 
through  sheer  ignorance  of  railway  costs,  by  making  rates  below 
the  cost  of  the  service  as  well  as  below  what  the  traffic  would  have 
borne.*^     Of  the  truth  of  Mr.  Haines'  statement  there  can  be  no 
reasonable  doubt.     Why,  then,  have  the  railways  administrators 
not  insisted  that  accounts  be  kept  in  such  a  way  as  to  facilitate 
the  process  of  finding  the  cost  of  the  service,  and  why  have  they 
not  developed  a  system  comparable  with  those  used  in  the  best 
manufacturing  and  commercial  establishments?     The  answer  is 
evident.     First,  the  operations  are  more  complicated  and  there- 
fore the  problem  is  more  difficult  of  solution.      Second,   the 
railways  administrators  have  in  most  cases  been  so  fully  occupied 
with  taking  care  of  the  traffic  offered  that  they  have  not  felt  the 
need  of  determining  costs  as  a  means  of  self -protection.     Third, 
the  railway  officials  have  been  trained  in  a  school  where  the 
principal  maxim  has  been  "charge  all  the  traffic  will  bear,"   and 
they  have  generally  believed  that  the  traffic  will  bear  in  nearly  all 
cases  somewhat  more  than  the  cost  of  the  service.     And,  fourth, 
railway  accounting,  as  all  other  accounting,  has  been  developed 
for  the  chief  purpose  of   protecting  the   proprietors'   interest 
against  fraud,  mistakes  and  theft.     It  is  only  in  recent  years  that 
administrators  have  begun  to  use  the  science  of  accounting  as  an 
aid  to  increased  efficiency  of  the  various  departments  and  of  the 
institution  as  a  whole.*^     Some  of  the  more  progressive  adminis- 

*■  Haines,  "American  Railway  Management,"  p.  24-27. 
*•  Duncan,     "A     Definition    of     Accounting."    Journal     of    Accountancy, 
February,  1909. 


Railway  Freight  Rates.  29 

trators  are,  however,  giving  cost  accounting  as  applied  to  rail- 
ways the  attention  which  its  importance  deserves,  and  it  is  entirely- 
safe  to  predict  that,  largely  as  a  result  of  this  recent  movement, 
an  orderly  and  equitable  system  of  railway  rates  will  be  gradually 
developed  in  the  United  States. 

Perhaps  the  most  important  contribution  to  the  science  of 
railway  accounting  in  connection  with  the  cost  of  the  service  is 
to  be  found  in  the  work  of  Mr.  T.  M.  R.  Talcott  in  the  manage- 
ment of  several  of  the  southern  railways,  the  results  of  which  are 
published  in  a  volume  of  less  than  one  hundred  pages.^*^  It  is, 
of  course,  impossible  to  give  anything  more  than  a  mere  outline 
of  Mr.  Talcott's  method  of  determining  the  cost  of  transporting 
goods  and  persons  without  reproducing  a  considerable  portion  of 
his  book.  In  brief,  the  system  is  as  follows:  transportation 
includes  three  classes  of  service  in  varying  proportions,  viz.,  train 
mileage,  car  mileage,  and  gross  ton  mileage  for  both  the  passenger 
and  the  freight  departments.  Accounts  must  therefore  be  kept 
showing  each  of  these  items  in  both  passenger  and  freight  busi- 
ness. Wherever  it  is  impossible  to  keep  the  expenses  separate, 
they  are  apportioned  between  passenger  and  freight  service  as 
follows :  ( I )  fixed  expenses,  including  administration,  taxes, 
maintenance  of  way,  and  interest  on  investment  are  divided  on  the 
basis  of  the  relative  gross  ton  mileage  with  proper  corrections  for 
the  speed  of  the  train  service;  (2)  terminal  expenses  are  directly 
separated  for  most  items;  (3)  train  expenses  are  directly  sepa- 
rated in  practically  all  cases;  (4)  car  expenses  are  directly 
separated  in  the  same  way ;  (  5  )  gross  tonnage  expenses,  covering 
fuel,  water,  and  wear  and  tear  of  track,  and  apportioned  on  the 
basis  of  relative  gross  ton  mileage  with  proper  allowance  for 
relative  speed  of  trains. 

It  is  possible  by  this  system,  Mr.  Talcott  finds,  actually  to  sepa- 
rate not  less  than  75  per  cent,  of  all  the  expenses ;  and  he  found, 
in  applying  this  method  of  separation  to  a  particular  case  for  the 
remaining  25  per  cent.,  that  the  passenger  cost  was  29^  per  cent. 

^  "Transportation  by  Rail :  an  analysis  of  the  maintenance  and  operation 
of  railroads,  showing  the  character  and  cost  of  the  service  performed  by 
railway  companies  in  the  maintenance  of  highways  for  commerce  and  as 
common  carriers  of  passengers,  freight,  and  the  United  States  mails  over 
such  highways." 


20  Yale  Review. 

while  that  of  the  freight  department  was  70.5  per  cent.  Having 
determined  the  total  cost  of  the  freight  service,  Mr.  Talcott  pro- 
ceeded to  analyze  the  cost  of  the  various  classes  of  freight  traffic. 
This  is  accomplished  by  first  finding  "units  of  cost"  of  the  freight 
service  for  the  most  important  classes  of  freight ;  then,  using  these 
units  of  cost,  it  is  of  course  possible  to  find  the  total  cost  of  addi- 
tional classes  of  service  of  any  particular  kind  where  the  condi- 
tions approximate  those  for  which  the  units  of  cost  are  known. 
By  means  of  a  large  number  of  experiments  the  additional  cost 
of  increased  speed,  of  curvature,  and  of  grades  was  also  deter- 
mined ;  and,  on  the  other  hand,  the  saving  due  to  heavier  rails 
and  larger  and  more  powerful  locomotives  could  be  found  for 
both  the  freight  and  the  passenger  service.  Two  further  condi- 
tions were  subjected  to  the  same  careful  analytical  test,  viz.,  the 
relation  to  the  cost  of  the  service  of  weight  and  value  in  propor- 
tion to  bulk,  and  also  the  relative  cost  of  long  and  short  distance 
traffic.  •  The  method  used  in  the  first  case  is  not  presented  in 
detail,  but  the  general  principle  adopted  may  be  stated  approxi- 
mately as  follows :  for  a  given  tonnage  the  cost  of  transportation 
varies  directly  with  value,  since  the  railway  is  the  insurer  of  the 
goods  while  in  its  possession,  and  directly  with  the  space  occupied, 
since  bulky  goods  reduce  the  proportion  of  the  paying  load  to  the 
gross  tonnage.  The  second  question  is  worked  out  in  consider- 
able detail,  but,  owing  to  the  fact  that  the  data  kept  by  the  rail- 
road were  not  completely  separated  for  the  through  and  local 
traffic,  certain,  assumptions  were  made  and  only  approximate 
results  were  reached.  The  general  conclusions  drawn  from  the 
statistical  analysis  of  the  operation  are  stated  as  follows : 

(a)  If  the  number  of  tons  of  freight  handled  by  each  train  is  the  same 
and  the  average  load  of  one  of  them  is  reduced  during  its  run  without 
reduction  in  the  average  number  of  cars  per  train,  the  terminal,  train  and 
car  expenses  are  the  same  per  ton  notwithstanding  the  difference  in  the 
average  hauls  and  only  the  fixed  and  gross  tonnage  expenses  are  variable 
per  ton  mile. 

(b)  If  the  number  of  tons  handled  by  each  train  is  the  same,  and  not  only 
the  average  load  but  also  the  number  of  cars  is  reduced  during  the  run,  the 
terminal  and  train  expenses  are  the  same  per  ton  notwithstanding  the 
difference  in  the  average  haul  of  the  freight;  and  the  fixed,  car,  and  gross 
tonnage  expenses  are  variable  per  ton  mile. 

(c)  If  the  number  of  tons  handled  by  each  train  is  not  the  same,  whether 
the  number  of  cars  is  the  same  or  not,  only  the  terminal  expenses  are  the 


Railway  Freight  Rates.  31 

same  per   ton   and   the   fixed,   train,   car   and   gross   tonnage   expenses   are 
variable  per  ton  mile." 

As  a  result  of  this  process,  the  approximate  cost  of  transporta- 
tion per  ton  mile  on  the  given  railway  of  189  miles  was  found  to 
be  as  follows : 


Constants. 

Cents  per  ton. 

Cents  per  ton  mile. 

10  miles 

61.98 

6.198 

50      " 

9195 

1.825 

100      " 

127.83 

1.279 

150      " 

164.41 

1.096 

189      " 

192.95 

1.021 

The  cost  per  ton  is  thus  found  to  be  proportional,  not  to  the 
distance,  but  to  a  certain  function  of  the  distance.  This  function 
varies  with  actual  operating  and  traffic  conditions,  but  it  is  inter- 
esting to  note  that  Mr.  Talcott  finds  it,  for  practical  purposes, 
approximately  proportional  to  the  square  root  of  the  distance. 

The  system  inaugurated  by  Mr.  Talcott  and  used  for  a  period 
of  years  to  determine  the  cost  of  transportation  on  a  small 
railway  may  be  applied  to  the  operations  of  any  railway,  however 
extensive  and  however  complicated  its  operations,  by  competent 
railway  accountants  or  by  any  commission  availing  itself  of  the  aid 
of  such  accountants,  provided  the  necessary  books  are  regularly 
and  properly  kept.  It  differs  from  the  Wisconsin  system  chiefly 
in  the  use  made  of  the  gross  ton  mileage  as  a  basis  for  pro-rating 
the  fixed  expenses,  maintenance  of  way,  and  the  cost  of  moving 
trains.  Since  records  showing  the  gross  ton  mileage  are  not 
always  kept  by  the  railroads — and  even  if  kept,  are  not  usually 
available  to  the  public — it  is  impossible  to  apply  the  two  methods 
above  described  to  a  particular  railway  and  secure  a  comparison 
of  results.  It  seems  probable,  however,  from  a  careful  examina- 
tion of  the  two  processes,  that  the  final  results  in  such  a  compari- 
son would  not  materially  differ. 

VI. 

The  chief  difficulties  encountered  in  determining  the  cost  of 
transporting  freight  are  thus,  it  will  be  noticed,  not  primarily 
economic  or  accounting,  but  commercial;    it  therefore  follows 

"  Talcott,  "Transportation  by  Rail,"  p.  72. 


-2  Yale  Review, 

that  if  all  commodities  could  be  reduced  to  a  common  unit  com- 
parable  with   the    passenger   mile   in   passenger    traffic,    these 
difficulties  would  largely  disappear.     Such  a  plan  has  been  pro- 
posed, discussed,  and  partially  formulated,  but  with  small  expecta- 
tion of  its  immediate  adoption  by  the  railroads,  owmg  to  the 
fact  that  it  would  to  a  considerable  extent  interfere  with  the 
present  practice  of  charging  what  the  traffic  is  supposed  to  be 
able  to  bear.     Such  a  plan  has  no  inherent  difficulties  and  cer- 
tainly is  no  more  complicated  than  the  present  system  of  classified 
and  commodity  rates.     The  real  difference  is  this:   The  present 
system  is  the  result  of  the  experience  of  three-quarters  of   a 
century,  and  has  become  a  part  of  our  commercial  and  industrial 
system.'    To  formulate  and  adopt  a  universal   freight  unit  in 
which  the  elements  of  weight,  space,  value  and  f  ragibility  should 
enter  in  proper  proportion  would  constitute  a  revolution  in  the 
commercial  world  comparable  to  that  great  alteration  of  view- 
point which  followed  the  discovery  of  the  sphericity  of  the  earth 
or  of  the  circulation  of  the  blood.     The  commercial  world  would, 
in  all  probability,  adapt  itself  to  the  new  system  with  less  difficulty 
than  was  experienced  in  converting  men  to  a  rational  view  of  the 
structure  of  the  universe  and  of  the  human  body.     With  the 
inauguration  of  such  a  system,  competition  in  the  industrial  and 
commercial  spheres  would  resume  its  normal  condition  to  a  much 
larger  extent  than  is  possible  at  present.     The  natural  rivalry  of 
manufacturers  and  merchants  would  then  be  directed,  in  the 
absence  of  obstructions  imposed  by  an  arbitrary  system  of  rail- 
way rates,  toward  supplying  the  goods  most  dearly  prized  and 
therefore  of  highest  commercial  value,  it  being  understood  that 
the  railroads  would,  under  this  system,  serve  all  localities  and  all 
commodities    on    substantially    similar    terms.      Discrimination 
between  commodities  and  places,  just  as  discriminations  between 
persons,  would,  as  a  result,  become  a  thing  of  the  past.     This  is 
the  goal  toward  which  the  industrial  and  commercial  world  is 
moving,  and  when  it  is  reached,  the  "absolute  test  of  a  reasonable 
rate"  will  have  been  found. 

Maurice  H.  Robinson. 

The  University  of  Illinois. 


3  0112  062003451 


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